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1 REVENUE OUTLOOK Revenue Summary Oregon s General Fund revenue growth slowed at the end of fiscal year 2015, as collections of personal income taxes dried up during May and June. Income taxes withheld out of paychecks slowed sharply, and the tax filing season ended with very weak payments as well. When the last of the 2014 income tax returns were processed in early summer, payments came in much lower than in recent years, despite a very big overall season for collections. Oregon s tax collections have since picked back up, growing rapidly to start off fiscal year As a result of weakness in income tax collections at the end of the biennium, General Fund revenues fell short of the May 2015 forecast. General Fund revenues for the biennium came in $56 million below forecast, reducing the ending balances that were set aside by budget writers in June. Although the General Fund ending balance for the biennium has become smaller, the associated reduction in available resources for the current biennium is largely offset by Oregon s kicker law. With less personal income tax having been collected than was expected in May, revenues have moved closer to the kicker threshold, resulting in a smaller credit for tax filers next year. Excluding corporate taxes, General Fund revenues exceeded the 2% kicker threshold by $111 million (0.7%), resulting in a kicker credit of $402 million. Due to actions taken by the 2011 Legislature, this kicker payment will take the form of a credit on 2015 tax returns rather than being issued as a check at the end of the year. Recent trends in corporate tax collections have been roughly the opposite of those for personal income tax collections. Corporate tax collections ended fiscal year 2015 growing at a very rapid pace, but have stalled out during the summer months. Corporate tax revenues 1 exceeded the 2% kicker threshold by $38 million (3.6%), resulting in a kicker amount of $59 million. 2 Due to a 2012 ballot measure, this amount will be dedicated to K-12 funding. Looking ahead through the rest of the current biennium, the outlook for available General Fund and Lottery resources has remained relatively unchanged. Although downside risks are mounting, the underlying outlook for employment and income growth has remained stable, leading to a stable revenue outlook. The revenue outlook is stable, yet uncertain. Volatility in equity markets is injecting a great deal of risk into the forecast. Oregon s budget depends heavily on personal income tax collections tied to realizations of capital gains. These collections are extremely volatile, with revenues subject to the sometimes unpredictable behavior of investors. Although housing wealth has played a larger role in driving taxable capital gains over the last decade than in the past, earnings and losses in stock markets account for the lion s share of movements in taxable capital gains in the typical year. 1 Excluding minimum taxes paid by S-Corporations, which are not part of the corporate kicker base. 2 Personal and corporate kicker calculations in the September 2015 forecast reflect a change in the interpretation of how General Fund carve-outs (Corporate Min Tax Rainy Day Transfer-ORS , Gain Share-ORS285C.635) interact with the kicker law. These carve-outs are no longer removed from the kicker base.

2 A 10% drop in stock prices will typically lead to a decline of twice that rate or more in the amount of net capital gains reported on tax returns. This negative impact on personal income tax collections is often delayed for several months after investors pull their assets out of equity markets. During a sell-off, the volume of trades increases, and paper gains from past years become subject to tax. Afterward, taxable capital gains face considerable downward pressure, with paper earnings from past years having been tapped, and with losses being carried forward into future tax years. This potential boom-bust swing in capital gains takes on added significance given the stage of the budget cycle. If equity markets fall sharply this year, tax payments will remain healthy through fiscal year 2016, with large revenue losses to follow in fiscal year Revenue losses at the end of a given biennium are particularly hard for policymakers to deal with. The impact of any spending cuts or tax increases is limited by the fact that most of the money for the budget period has already gone in or out. Eleventhhour revenue losses following the 2001 recession led to a bulge of debt that the state only recently paid off. For now, the revenue outlook calls for what amounts to a hiccup in equity prices. Should a full-blown market crash ensue, the revenue outlook could change significantly before the 2016 legislative session. Revenue growth in Oregon and other states will face considerable downward pressure over the 10-year extended forecast horizon. As the baby boom population cohort works less and spends less, traditional state tax instruments such as personal income taxes and general sales taxes will become less effective, and revenue growth will fail to match the pace seen in the past.

3 General Fund Revenues General Fund revenues for the biennium are estimated to have been $16,105 million. This represents a decrease of $56 million (-0.3%) from the May 2015 forecast, and an increase of 13.7% relative to the biennium. General Fund revenues for the biennium came in $462 million (3.0%) above the Close of Session forecast. Personal Income Tax Personal income tax collections were $2,426 million for the fourth quarter of fiscal year 2015, $39 million (1.6%) below the latest forecast. Compared to the year-ago level, total personal income tax collections grew by 10.8% relative to a forecast that called for 12.6% growth. Table B.8 in Appendix B presents a comparison of actual and projected personal income tax revenues for the April-June quarter. Excluding corporate taxes, General Fund revenues exceeded the 2% kicker threshold by $111 million (0.7%), resulting in a kicker credit of $402 million. Due to actions taken by the 2011 Legislature, this kicker payment will take the form of a credit on 2015 tax returns rather than being issued as a check at the end of the year. This would generate a credit of around $124 for the median Oregon income tax filer. The top 1% of income earners would receive an average credit of $4,614 per tax return. Corporate Excise Tax Corporate excise tax collections equaled $201 million for the fourth quarter of fiscal year 2015, $19 million above the May forecast. Some of the large increase in corporate tax collections over the last few months is likely technical in nature, with the pattern of processing having changed due to an upgraded IT system. After a few more months under the new processing system, the collections data should settle into its new trend. July collections came in well below what they were last year. Corporate tax collections would likely be near record levels even without technical issues. Outside of energy production and mining, profitability remains strong in most industries. Also, recent law changes have supported collections, as has a decline in outstanding Business Energy Tax Credits. Corporate income tax collections for ended the biennium 5.7% higher than what was called for in the Close of Session forecast. This generates a corporate kicker amount of $59 million to be dedicated to K-12 education. Other Sources of Revenue Among other primary sources of revenue, secretary of state fees, video lottery sales and criminal fines have been coming in above expectations in recent months. Cigarette and estate taxes have been coming in somewhat below forecast.

5 Table R.2 General Fund Revenue Forecast Summary (Millions of Dollars, Current Law) Forecast Forecast Forecast Forecast Forecast Forecast % % % % % % Revenue Source Biennium Chg Biennium Chg Biennium Chg Biennium Chg Biennium Chg Biennium Chg Personal Income Taxes 13, % 15, % 17, % 19, % 21, % 23, % Corporate Income Taxes 1, % 1, % 1, % 1, % 1, % 1, % All Others 1, % 1, % 1, % 1, % 1, % 1, % Gross General Fund 16, % 18, % 19, % 21, % 23, % 25, % Offsets and Transfers (74.2) (43.5) (73.6) (76.4) (80.1) (79.2) Net Revenue 16, % 17, % 19, % 21, % 23, % 25, % Revenue growth in Oregon and other states will face considerable downward pressure over the 10-year extended forecast horizon. As the baby boom population cohort works less and spends less, traditional state tax instruments such as personal income taxes and general sales taxes will become less effective, and revenue growth will fail to match the pace seen in the past. General Fund revenues are expected to total $19,747 million in biennium, an increase of 9.7% percent from the prior period, and $43 million above the May forecast. In the biennium, revenue growth is expected to remain stable, followed by rates of around 9% to 10% in subsequent biennia. The slowdown in long-run revenue growth is largely due to the impact of demographic changes and changes in savings behavior. In particular, the labor force will lose many very productive workers with a lifetime of experience over the coming years. Table B.2 in Appendix presents a more detailed look at the long-term General Fund revenue forecast. Tax Law Assumptions The revenue forecast is based on existing law, including measures and actions signed into law during the 2015 Oregon Legislative Session. OEA makes routine adjustments to the forecast to account for legislative and other actions not factored into the personal and corporate income tax models. These adjustments can include expected kicker refunds, when applicable, as well as any tax law changes not yet present in the historical data. A summary of actions taken during the 2015 Legislative Session can be found in Appendix B Table B.3. For a detailed treatment of the components of the 2015 Legislatively Enacted Budget, see: LFO Budget Summary. Although based on current law, many of the tax policies that impact the revenue forecast are not set in stone. In particular, sunset dates for many large tax credits have been scheduled. As credits are allowed to disappear, considerable support is lent to the revenue outlook in the outer years of the forecast. To the extent that tax credits are extended and not allowed to expire when their sunset dates arrive, the outlook for revenue growth will be reduced. The current forecast relies on estimates taken from the

6 Oregon Department of Revenue s Tax Expenditure Report together with more timely updates produced by the Legislative Revenue Office. Alternative Scenarios The latest revenue forecast for the current biennium represents the most probable outcome given available information. OEA feels that it is important that anyone using this forecast for decision-making purposes recognize the potential for actual revenues to depart significantly from this projection. Currently, the overwhelming downside risk facing the revenue outlook is the threat that the U.S. economic recovery will lose steam in the near term. Such a scenario, however it played out, would result in drastic revenue losses. Two recessionary scenarios are displayed in table R.2b. In a severe recession, biennial revenues could come in as much as $2 billion lower than predicted 3. 3 The methodology for computing alternative scenarios has been changed to reflect recent work done by the Legislative Revenue Office. Assumptions: Recessions begin in 2015 and return to baseline income by The moderate recession scenario assumes personal income growth will be reduced by one-half relative to the baseline in 2015 and The severe recession scenario assumes personal income will decline in 2015 by as much as it did in The percentage deviation in personal income taxes is 1.4 times the deviation in personal income. The percentage deviation in corporate income taxes is 2.0 times the deviation in personal income.

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